The thought of cigarette giant British American Tobacco (BAT) as a “predominantly smokeless” business by 2035 seems far-fetched. But the smokeless product market is growing apace — though grabbing a lucrative share of the world’s biggest market, the US, has its own challenges.
BAT — famous for its cigarette brands including Lucky Strike, Pall Mall, Kent, Camel and Dunhill — is working hard to establish compelling market shares for new smokeless products under brands such as Velo (nicotine pouches), glo (tobacco heated products) and Vuse (vapes). At the end of the first half of this year, BAT reported that just 18% of group revenue was derived from smokeless products.
But at a capital markets presentation last week, BAT CEO Tadeu Marroco said that if the US combustible business was stripped out, then 27% of revenue would come from smokeless products.
“Is this as much or as fast as I would want? The answer is no, but this is far ahead of most of our peers,” he said.
If there is a warm glow for shareholders, it is that BAT has managed to achieve profitability in its smokeless business two years ahead of schedule.
While the number of consumers using smokeless products has doubled since 2018, Marroco stressed there is still a “huge pool” of more than a billion cigarette consumers who could still switch to smokeless products.
This is a big number for BAT, with smokeless products considerably more profitable than the traditional combustibles or cigarettes. But there are challenges, particularly in the vast US market.
BAT disclosed that in Europe, more than a third of total nicotine consumers are actively using new-category smokeless products.
According to Marroco, BAT sells at least one new-category product in 44 markets across Europe. He emphasised that all three smokeless categories are margin-accretive for BAT in Europe. “Heated products consumables are almost twice as profitable as combustibles. Vapour products are more than 1½ times more profitable. And modern oral pouches are more than four times more profitable than combustibles.”
Marroco said in Europe, BAT was historically strongest in the value-for-money and the low segments of the combustibles market — “which make the size of the prize for BAT particularly high to convert combustibles consumers to smokeless offers”.
There are roughly 25-million vape consumers in the US against 34-million cigarette smokers
If Europe is a sweet spot for BAT, then surely the sprawling US market is a potential game-changer in the smokeless quest?
Roughly a third of the global nicotine value pool is found in the US. But BAT is not blazing as brightly as expected in that part of the world, with an astounding 70% of US vaping revenues generated from illegal flavoured products.
If BAT can convince the authorities to get a grip on this scourge, there could be considerable opportunity — in the form of a £6bn market that BAT is unable to access at the moment.
David Waterfield, CEO of BAT subsidiary Reynolds American, estimated the US nicotine revenue pool at £41bn, growing at a compound annual growth rate of more than 2.5% between 2021 and 2023.
“The growth is driven by consumer demand for vapour and more recently nicotine pouches, or what we also call modern oral,” he said. “This sizeable and growing contestable space is being created by almost 40-million consumers who are using nicotine products across categories … making it the ideal market for BAT’s mission to build a smokeless world.”
Vapes alone are estimated to be a £9bn revenue pool in 2024. Of this, rechargeable vapes make up £1.5bn but a hefty £6bn are single-use vapes.
There is a catch. Waterfield said: “Today, almost 70% of the vapour revenue pool is what we call a grey market, made up of either illegal products or products which claim to have PMTAs [pre-market tobacco product applications] pending.”
There are roughly 25-million vape consumers in the US against 34-million cigarette smokers. So BAT would want a markedly bigger chunk of this. Waterfield said that by 2030, vapes are projected to grow by £5bn to an anticipated revenue pool of up to £14bn. “Again, this is a projected consumer demand irrespective of enforcement.”
At the presentation Jeff Raborn, BAT’s law and external affairs executive, said that for more than a year the group had “engaged credibly and effectively” with US regulators over illegal smokeless products. “So, we have 50 pending PMTAs … and more marketing grant orders, 22 of them, more than anyone else in the industry. So, no-one has more interest in this than we do. It’s been a long road, and it will remain a long road, but we are starting to see progress on the enforcement front.”
He said the US Food & Drug Administration (FDA) had proposed a rule requiring tracking numbers for imports, which would help customs and border protection to stop illegal shipments.
“Also, the FDA has ramped up frequency of its warning letters, seizures and monetary penalties — almost 1,500 letters in 2024 alone, with 50% of them aimed at single-use products. Seizures are up year on year by almost 250%, and monetary penalties are up as well.”
Overall, BAT — one of the dependable dividend payers for local investors — is targeting an operating profit growth range of 4%-6%. Marroco said: “We’ll be able to achieve this growth rate with 0%-2% combustibles [cigarette] growth, given the strong growth opportunities we have in the new categories.”
If enforcement in the US takes hold properly, BAT’s bottom line may be even more impressive in the medium term.
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